FINANCIAL DECISIONS

v  FINANCIAL DECISIONS
FINANCIAL MANAGEMENT
BUSINESS STUDY
A CONCEPTUAL SERIES ON COMPETITIVE EXAM FOR COMMERCE AND MANAGEMENT LEC 6

·         FINANCIAL DECISIONS

·         CONTENTS: EXPLANATIONS OF FINANCIAL DECISIONS,THEIR INTERRELATIONSHIP AND IMPORTANT HINTS FOR  SHORT QUESTIONS

·         FINANCIAL DECISIONS REFERS TO DECISIONS CONCERNING FINANCIAL MATTERS OF A BUSINESS. THE OBJECTIVE OF THESE DECISIONS IS TO MAXIMIZE THE WEALTH OF SHARE HOLDERS.AN EFFICIENT FINANCIAL DECISIONS INCREASES THE PRICE OF THE SHARE WHERE AS POOR FINANCIAL DECISION RESULTS INA DECLINE OF SHARE PRICE.

·         FINANCIAL MANAGEMENT IS CONCERNED WITH THREE BROAD DECISIONS:-

1.     INVESTMENT DECISIONS

2.     FINANCING DECISIONS

3.     DIVIDEND DECISIONS

v  FINANCIAL DECISIONS

v     INVESTMENT DECISIONS

•          THEY RELATE TO THE DETERMINATION OF TOTAL AMOUNT OF ASSETS TO BE HELD IN THE FIRM, COMPOSITION OF THESE ASSETS AND THE BUSINESS RISK COMPLEXITIES OF THE FIRM PERCEIVED BY THE INVESTORS.

•          INVESTMENT DECISIONS ARE OF TWO TYPES:-

•            1.LONG TERM INVESTMENT DECISIONS( CAPITAL BUDGETING DECISIONS):-INVOLVE COMMITMENT OF FUNDS FOR LONG TERM AND IT IS THE PROCESS OF MAKING INVESTMENT DECISIONS IN FIXED ASSETS WHICH WILL GIVE BENEFITS FOR LONG PERIOD OF TIME.INVESTMENT DECISIONS PLAY A VERY SIGNIFICANT ROLE:

a.    GENERATE AND INFLUENCE THE EARNING CAPACITY

b.    INVOLVE HUGE AMOUNT AND THESE ARE IRREVERSIBLE DECISIONS

•          2. WORKING CAPITAL DECISIONS(SHORT TERM INVESTMENT DECISIONS):-RELATED TO ALLOCATION OF FUNDS AMONG CURRENT ASSETS SUCH AS CASH AND ITS EQUIVALENT,RECEIVABLES AND INVENTORIES.

a.    AFFECT THE DAY TO DAY WORKING,LIQUIDITY AND PROFITABILITY

b.    A SOUND WORKING CAPITAL MANAGEMENT POLICY IS ONE WHICH ENSURES EFFICIENT CASH MGMT.RECEIVABLE MGMT AND INVENTORY MGMT.

v  FACTORS AFFECTING CPAITAL BUDGETING DECISIONS

•          CASH FLOW OF THE PROJECT

•          RATE OF RETURN

•          THE INVESTMENT CRITERIA INVOLVED

v     FINANCIAL DECISIONS

´  FINANCING DECISIONS ARE THE DECISIONS ABOUT THE QUANTUM OF FIANCE TO BE RAISED FROM VARIOUS LONG TERM SOURCES AND HOW MUCH TO BE RAISED FROM EACH SOURCE.

´  THE SOURCES OF THE FUNDS:-

•            OWNER’S FUNDS:-THROUGH ISSUE OF SHARES AND RETAINED EARNINGS AND THESE ARE AVAILABLE  ON PERMANENT BASIS

•            BORROWED FUNDS:-MAY BE IN THE FORM OF DEBENTURES,BONDS,SHORT TERM LOANS ,LONG TERM LOANS ETC. THESE ARE THE LIABILITIES BUT ALSO THE PAYMENT OF INTEREST ON BORROWED FUNDS IS DEDUCTIBLE EXPENSES AND REDUCE THE TAX LIABILITY BUT COMPULSION OF INTEREST AND PRINCIPAL ARE THE RISK ASSOCIATED WITH IT.

•          A FINANCE MANAGER HAS TO DECIDE A MIX OF BORROWED FUNDS AND OWNERS FUNDS.

•                  FACTORS AFFECTING FINANCING DECISIONS

1.     CASH FLOW POSITION

2.     COST

3.     RISK:-OPERATING RISK/BUSINESS RISK AND FINANCIAL RISK

4.     FLOTATION COST

5.     FIXED OPERATING COST

6.     CONTROL CONSIDERATIONS

7.     CONDITIONS OF CAPITAL MARKET

8.     TAX RATE

9.     RETURN ON INVESTMENT

10.  REGULATORY FRAMEWORK

v  DIVIDEND DECISIONS

•          THE TERM DIVIDEND REFERS TO THAT PART OF THE PROFITS OF THE COMPANY WHICH IS DISTRIBUTED AMONG THE SHAREHOLDERS. A DECISION HAS TO BE TAKEN HOW MUCH SHOULD BE PAID AS DIVIDNED AND HOW MUCH SHOULD BE KEPT IN THE FORM OF RETAINED EARNING.

•          FACTORS WHICH AFFECT DIVIDEND DECISIONS:-

1.     AMOUNT OF EARNINGS

2.     STABILITY OF EARNINGS

3.     GROWTH OPPORTUNITIES

4.     SHAREHOLDER’S PREFERENCE

5.     LEGAL CONSTRAINS

6.     STOCK MARKET REACTIONS

v     INTER RELATION OF FINANCIAL DECISIONS

v  INTER RELATION OF FINANCIAL DECISIONS

1.     FOR TAKING OF DECISION OF INVESTMENT CAN NOT BE TAKEN WITHOUT AVAILABILITY OF FINANCE.

2.     THE FINANCING DECISION IS IN TURN INFLUENCED BY AND ALSO INFLUENCES THE DIVIDEND DECISIONS.

3.     AN EFFICIENT FINANCIAL MANAGEMENT HAS TO CONSIDER AND EVALUATE EACH OF THE DECISIONS AND ITS IMPACT ON SHAREHOLDER’S WEALTH.

v  IMPORTANT SHORT QUESTIONS

1.     THE CHEAPEST SOURCE OF FINANCE:- RETAINED EARNING

2.     A DECISION TO ACQUIRE A NEW AND MODERN PLANT TO UPGRADE AN OLD ONE IS INVESTMENT DECISIONS

3.     OTHER THINGS REMAINING THE SAME,INCREASE IN THE TAX RATE ON CORPORATE PROFIT WILL MAKE THE DEBT RELATIVELY CHEAPER

4.     COMPANIES WITH HIGHER GROWTH PATTERN ARE LIKELY TO PAY LOWER DIVIDENDS

5.     FINANCIAL LEVERAGE IS FAVORABLE IF RETURN ON INVESTMENT IS HIGHER THAN COST OF DEBT

6.     HIGHER DEBT EQUITY RATION RESULT IN HIGHER DEGREE OF FINANCIAL RISK

7.     HIGHER DIVIDEND PER SHARE IS ASSOCIATED WITH HIGH EARNING,HIGH CASH FLOWS,STABLE EARNINGS AND LOWER GROWTH OPPORTUNITIES